Credit: Shutterstock photoBy Erymanthos :
Investment highlights
- Strong historical growth: 12-year revenue CAGR of 17.5%. Revenue has increased in 11 of the past 12 years-only down year was 2009 (where sales were down 0.6%).
- No institutional ownership: Largest institutional shareholder is Vanguard, who owns 1.1% ofthe company.
- High insider ownership: CEO Chris Reed and his wife, Judy, own 18.5% ofthe company. Chris's brother, Robert Reed, also owns 6.2% ofthe company.
- Strong brand name: Reed's and Virgil's brand names are well known in natural food stores where they face little competition and are awarded several rows of prime shelf space.
- Significant growth expected in Kombucha category: Kombucha is growing by 30.0%+ a year is expected be a $500.0 million industry in 2015. One player, Millennium Products, Inc. dominates the market with up to 75.0% - 85.0% share according to some industry professionals. Reed's has established itself as a strong #2 in this category after only launching in H2 12, with sales growing 50.0%+.
- Tripling of manufacturing output will result in significant savings: Thecompany is investing in its LA plant to triple production speed, which will support sales up to $100.0 million - $120.0 million.
- First national TV advertisements will drive growth: First national TV commercials aired in July and September, which are expected to increase brand awareness and drive growth.
Company description
Products
- Reed's brand Ginger Brew
- Virgil's brand sodas, and
- Culture Club Kombucha
Reed's Ginger Brew: Ginger ale is the oldest known soft drink in the world. Before modern soft drink technology existed, non-alcoholic beverages were brewed at home from various herbs, roots, spices, and fruits. Chris set out to replicate this old tradition back in 1987 and came across a Jamaican recipe for ginger ale. After years of experimentation, Reed's Ginger Brew was born. Reed's Ginger Brews contains 8 and 26 grams of fresh ginger in every 12 oz bottle. The product differs from other soft drinks because it is produced with natural carbonation through a slow beer-like brewing process.
Currently, Reed's sells seven flavors of Ginger Brew, including Original Ginger Brew, Extra Ginger Brew, Premium Ginger Brew, Raspberry Ginger Brew, Spiced Apple Ginger Brew, Cherry Ginger Brew, and Extra Ginger Brew-Light (~55 calories).
Virgil's Sodas: In 1999, Chris borrowed $250,000 from his father and bought a small root beer company called Virgil's for $371,000 down and $100,000 a year for five years. Virgil's Root Beer was developed by Ed Crowley using a micro-brewed manufacturing process. Virgil's is a premium root beer using all natural ingredients from all over the world. Ingredients include cane sugar, licorice, bourbon vanilla, cinnamon, clove, wintergreen, sweet birch, molasses, nutmeg, pimento berry oil, balsam oil, and cassia oil.
Club Culture Kombucha:
Background on customers
Background on manufacturing
As a result, Reed's and Virgil's brand products are typically granted multiple rows of prime shelf space by retailers. Both brands sell extremely well in natural food chains, particularly Trader Joe's and Whole Foods. In fact, after talking to dozens of employees at Trader Joe's stores across the country, the response I got was nearly identically: the Reed's Ginger Brew sells incredibly well with little to no competition. Many employees also praised the Virgil's brand for selling well. The response was very similar at Whole Foods. The Reed's and Virgil's products sell so well that many retailers typically keep multiple cases in the back in case loyal customers order by the case full (each case contains 12 bottles).
Long-term catalysts
Kombucha market (and getting into all WFM locations):
Kombucha has experienced explosive growth in recent periods and the market is largely dominated by one player: As previously mentioned, kombucha is a fermented probiotic drink that is believed to provide a host of nutrients in addition to supposed healing and cleansing properties. What most Wall Street types don't realize is that the priobiotic drink category has exploded in popularity in recent years, especially kombucha among the health conscious crowd.
In fact, kombucha is the largest growth segment of the functional beverage category of drinks and foods, which includes coconut water, yogurt, and fresh juices. Throughout my research I came across several firms who have estimated varying growth rates for the kombucha industry. Further, I have talked to countless professionals in the natural food industry, including employees at Whole Foods. The overwhelming response I received is that kombucha is one of the fastest growing beverages out there today. Key highlights include:
- According to data from SPINS, in 2012 and 2013, kombucha sales increased 40.0% and 37.0%, respectively.
- SPINS estimates that from February 2013 to February 2014, kombucha sales increased 29.0% year-over-year.
- Kombucha Kamp (a Beverly Hills seller of equipment and ingredients to home brewers and commercial customers) believes kombucha will be a $500.0 million industry in FY 15.
Cracking the Kombucha market
After seeing the incredible growth of kombucha and learning that competitor GT's/Synergy used ginger (Reed's signature ingredient!) in its kombucha, Reed's decided to enter the market. Reed's launched in November of 2012 and has since secured the #2 spot behind GT's/Synergy.
Recent data points highlighting the incredible success of Reed's Kombucha:
- Reed's launched its kombucha line in FY 12 and it now accounts for 12.0% of revenue.
- Reed's Club Culture Kombucha is the number #2 kombucha brand in the country and is the only (in my view) national competitor to GT's/Synergy.
- YTD FY 14, Kombucha sales have increased 74.0% year-over-year to ~$3.0 million.
- In Q2 14, gross kombucha sales increased 35.0% year-over-year. Thecompany said that it experienced a packaging issue with its kombucha products (which stopped production for 2 - 3 weeks). Excluding that impact, kombucha sales would have increased 70.0%.
- In Q1 14, gross kombucha sales increased 143.0% year-over-year.
- Current guidance is for kombucha sales to increase 40.0% - 50.0% in FY 14.
Capturing share in the Kombucha market: So, the obvious question is how is Reed's can capture share in the kombucha market. After all, if you walk to the kombucha shelf of any Whole Foods around the country, you will see several rows of mid level shelf space (prime location) dedicated to dozens of flavors of the GT's/Synergy Kombucha, while Reed's is discreetly tucked away on the bottom shelf. Further, if you ask shoppers about kombucha, the brand they naturally gravitate to is GT's/Synergy.
I believe there are two main ways in which Reed's will grow in the kombucha market for the next few years:
- Further penetration into the Whole Foods store base, and
- National advertising (which I will talk about later).
Kombucha penetration in Whole Foods: Whole Foods is one of the largest retailers of kombucha in the US so it is paramount that Reed's penetrate the entire store base with its Kombucha (its Reed's Ginger Brew and Virgil's brand are already in all of the stores). It is important to understand how Whole Foods operates before further discussing penetrating the store base. Whole Foods splits its US operations into 11 regions consisting of North Atlantic, Mid-Atlantic, Northeast, Florida, South, Midwest, Southwest, Rocky Mountain, Pacific Northwest, Northern California, and Southern California.
Low-hanging fruit, opportunities to cut costs
- Reimbursements to its distributors for agreed portions of their promotional spend with retailers;
- Its agreed share of fees to distributors and/or directly to retailers for in-store marketing and promotional activities;
- Its agreed share of slotting, shelf space allowances and other fees given directly to retailers;
- Incentives given to thecompany's distributors and/or retailers for achieving or exceeding certain predetermined sales goals; and
- Discounted or free products.
While offering promotions and discounts is a healthy business activity to improve sales volume, in recent periods, Reed's has too aggressively handed out promotions and discounts. The level of promotional activity was so out of hand that on the last conference call, Chris said some of the promotions they ran were "just too rich". In fact, between Q3 13 and Q1 14, promotions and other allowances increased 210 basis points on average as a percentage of gross sales! Based on my observations from talking to multiple retail employees, Reed's product has amazing brand recognition and stores need to frequently restock the product because it sells out so quickly.
Valuation
(click to enlarge)
- Execution risk related to the LA plant expansion.
- Manufacturing inefficiencies result in margin compression.
- Execution risk related to thecompany's national TV advertising campaign.
- Sales execution risk (i.e. getting into all Whole Foods stores).
- Cutbacks in promotions/discounts result in lower sales.
- Kombucha is a fad and dies out.
Conclusion
Disclosure: I am long REED. Information in my report may be incorrect. Please perform your own due diligence.
See also Building Wealth With An Overvalued Stock? on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
